For many people, the pursuit of financial independence is like the quest for the Holy Grail—a noble goal forever just out of reach.
But in the case of real estate investors, this goal is actually attainable with a little forethought and planning. And when we say planning, we mean looking at more than just the property price and repair costs. Step back and consider the bigger economic picture including the opportunities presented by the current US tax structure.
Taking advantage of the tax laws governing real estate transactions is a wise and, potentially, lucrative strategy. One of the most useful tools in the investor’s arsenal is the 1031 exchange.
Let’s look a little more closely at how it works.
Structure Of the 1031 Exchange
At its essence, a 1031 exchange is an exchange of “like-kind” assets. Making this exchange allows an investor to defer any gains or losses as per Section 1031 of the Internal Revenue Code. Capital gains are not realized until the property is sold and not exchanged.
Some Technicalities
A 1031 exchange can only be used for investment or commercial property, not personal property. So, you can’t trade your primary residence for another. But you are not limited in the number of properties you can exchange. For instance, you can swap one property for multiple replacement properties and vice versa; you can swap multiple lower priced properties for one larger property. And in order to fully defer all taxes, the new property must be of equal or greater market value with the same or a greater amount of equity.
Timing Is Everything
Let’s say you’ve just sold your investment property and want to purchase an in-kind property via a 1031 exchange. On closing day, the clock starts ticking. You have 45 calendar days to identify up to three potential properties of like-kind. It’s also necessary that the replacement property be received and the exchange completed no later than 180 days after the sale of the exchanged property OR the due date of the income tax return (with extensions) for the tax year in which the original property was sold, whichever comes first. So, as you can see, time is of the essence.
Changes Made By The 2018 Tax Law
Real estate investors can rest easy. No new restrictions on 1031 exchanges of real property were made in the 2018 tax law. However, the new law did effectively limit 1031 exchanges to real property. This means 1031 exchanges of personal property, collectibles, aircraft, franchise rights, rental cars, trucks, heavy equipment and machinery, etc. are no longer permitted.
Practical Advice
Still have questions about how the 1031 exchange works or whether it would benefit you in particular? Reach out to us here at Navigator Private Capital to discuss your specific situation. We would be happy to design a loan solution that fits your needs to a T. Call us at 443.603.0193 or at info@gonavcap.com.